Office Apocalypse - Really?Jun 8, 2022
Sorry to pick on Bisnow, which I greatly respect, but they just blasted out this headline: Apocalypse Soon: Work From Home to Cut Office Values by $500B. Report Finds.
They say that "As remote work becomes a more permanent fixture — despite the edicts of a few billionaires on returning to the office — the values of office buildings are headed south, researchers predict. Office values in New York City will drop 28% by 2029, representing value destruction of $49B, according to a new study by academics at New York University and Columbia University, as lease revenue and the total number of leases drop."
The report, titled Work From Home and the Office Real Estate Apocalypse, was written by:
- Arpit Gupta – an Assistant Professor
- Stijn G. Van Nieuwerburgh—a finance professor
- Vrinda Mittal – a Ph.D. candidate
I couldn't figure out who are the billionaires they mention – I clicked the link, and it led me to Elon Musk, but I am assuming these unknowledgeable billionaires presumably refer to those who run companies like RXR, SL Green, and Vornado. I am confident it was not pure luck that these billionaires were able to become billionaires through NYC office ownership over the past twenty or thirty years.
Instead, these Columbia researchers, who, as far as I can tell, have zero actual real estate experience, make the headline. I tried to read the article, but full disclosure – I just couldn't do it. The equation on pages 2 and 3 of the report discouraged me from trying.
Now I am past ranting about the media sending out misleading information. Still, intellectually (philosophically?), I do know that if the writers don't come up with these articles – sometimes known informally as clickbait- no one will read their missives, and they will go out of business. And technically, their headline is correct in that is what the research says.
Anecdotally, over the many years I have been in real estate, I have listened to economists, and just about everyone under the sun who is super-educated in business schools make predictions. They always seem incredibly smart, but their actual predictions are generally wrong, or at least I find myself at a loss remembering anyone that was actually proved right in the end. Consider predictions in the past ten years about recessions, financial crises, housing, interest rates, and pretty much everything else. The reason is that there are too many variables for macro predictions to be that valuable.
Okay, so now that I have gotten that out of the way, here is my best attempt to assess office in NYC:
First – everyone – I mean everyone – I have spoken in the industry -- not economists or researchers – just people in the business – say that office leasing for first-class office space is on fire! Record rents and a ton of demand. And they also say that Class B or Class C space is struggling right now – and some say some of it is functionally obsolete.
Second – NYC is indeed struggling with the WFH issues, but I will stick with my prior predictions that WFH is a trend that started long ago – shot up during COVID – and will return to general growth.
I admit I have been quite off on the timing. I don't dodge being wrong when I am wrong. COVID has lasted longer than I guessed, and the worker shortage has blocked bosses from demanding that workers come back to work. Sooner or later, employees will conclude that they have to show up in the office for their careers to blossom, and employers will have enough hiring strength to insist. Even the Governor of our state called out the inconsistency that restaurants and ball games are packed, but offices are empty because people don't like the commute, etc.
So, where does this all leave us?
As Warren Buffett says, be fearful when others are greedy and be greedy when others are fearful. I can't see anything that people are more worried about right now than Class B and C office buildings in New York City. So that is where I would be looking for bargains.
My thinking is this:
It is still New York City. How often do you get to buy anything here for a low price? The last time was 2009. And the smart money stayed on the sidelines missing out on half a trillion dollars of value creation.
People seem to still want to be here. A year-ish ago, multifamily rents dropped like a stone, and now they are rising again. I note Starbucks is packed in the morning, as it takes forever for me to get my coffee. And when I pass a restaurant on the street, I see many people dining there. And I saw a basketball game a few weeks ago, and Madison Square Garden was full and sold out. So NYC is still NYC.
Condo prices rocketed up from the doldrums, although the rise in interest rates has dented that somewhat recently.
Many new projects are out there getting built right now, including – believe it or not – a fair number of ground-up office buildings – admittedly Class A.
If you are poking around the perceived wreckage of Class B and C office buildings, you will have precious little competition as I don't see anyone looking at it.
Just as affordable housing is critical for people who cannot afford luxury housing, it is the same for office space. There are numerous tenants and potential tenants that need/want to be in NYC but cannot afford the $100 PSF - $150 PSF - $200 PSF – and even $300 PSF rents that some of the mega-companies with enormous budgets can afford. There might be more than a few of these businesses who want to lease (affordable) space in these second-class buildings.
And then consider the media effect. If Bisnow is trumpeting a 28% decline, it likely scares away a lot of competition and pushes prices down even further than they should be pushed down. This is just like the newspapers did during the height of COVID when they made clear that NYC was toast and everyone was moving to Florida. Jerry Seinfeld – and me – disagreed.
If you are still reading and considering my thesis, interest rates have to be considered as well. And in that vein, I suspect that interest rates will have a lot more to do with the valuation of office buildings in NYC and (temporary) value destruction than anything else. And this, even more, creates opportunities. You real estate readers don't need me to tell you how to make a deal, but my sense is that rising rates will create even more real estate distress in NYC class B and C office buildings that cannot refinance and need rescue capital or recapitalization capital, which will lead to opportunities to acquire either the debt at a discount or co-venture with the equity to create win/win upside.
Finally, of course, I admit that I don't have a crystal ball, so my thinking might be dead wrong. However, I am not trotting out with mathematical formulas to predict an apocalypse with 28% accuracy. Instead, I am just saying that with the overall theory of buying low and selling high, NYC Class B and C office is certainly giving one the ability to buy low. To adjust for the risks of not being able to sell high, I would go with Buffett's margin of safety and suggest pricing (of debt or equity) that assumes that things get worse and that a building you buy into or lend on has to be partially or completely repurposed.
Bruce Stachenfeld, aka The Real Estate Philosopher™